Individuals purchase life insurance products for a variety of reasons, whether to simply ensure payment of funeral services, to provide additional income to the individual's family in case of an accident, or to provide financial security to a loved one. Corporations typically purchase or sponsor life insurance products as a financing vehicle for benefit plans or to hedge against other liabilities. Consequently, there are a variety of different types of life insurance products available for purchase.
For example, single premium life insurance allows a purchaser to pay a one-time fee, or premium, to receive a fully funded life insurance policy with a predetermined value (i.e., the face value). The death benefit under such a policy depends on the individual insured, the premium paid, and the face value of the policy. Typically, the premium payment is deposited into an interest bearing cash value account. The interest rate is compounded at specific intervals, usually annually. The interest rate may change periodically, but a single premium life insurance policy typically guarantees a minimum interest rate amount. In return, the insurance company charges a variety of fees, including an annual fee, mortality risk fee, and an administrative fee.
In addition, insurance companies typically charge a large penalty on a single premium life insurance policy if the insured withdraws money from the policy during the first few years. In addition, while the purchaser may take out a loan against the proceeds of this type of policy, interest rate charges may apply. The up-front premium usually represents a large portion of the face value of the policy.
Term life insurance provides a predetermined benefit payment to an insured/purchaser (i.e., an individual or a group purchasing the life insurance) for a specifically designated period, such as for one year, five years, ten years or fifteen years. The insurer only pays the face value if the insured (i.e., an individual or a person within the group) dies within the period in which the policy is in effect. However, if the insured lives longer than the term of the policy, the policy expires and pays nothing. Consequently, term life insurance does not build any equity. The principal advantage of term life insurance is that it is relatively inexpensive. Because of its speculative nature, term life insurance may be purchased as a means of temporary protection or when an individual cannot afford the cost of other forms of life insurance.
Other alternatives are renewable and non-renewable term life policies. With renewable term life insurance, a purchaser automatically re-qualifies and is able to continue the existing policy when the original term is up. A non-renewable policy simply indicates that when the policy expires, the individual must take another physical and answer more health questions in order to re-qualify for a new policy.
Insurers offer riders (i.e., provisions in the insurance policy allowing for amendments to its terms and/or coverage) in order to improve the return characteristics. For example, many term life insurance policies are convertible. Convertible term life policies allow the insured to exchange the term policy into a permanent form of life insurance. However, the costs associated with the conversion are high, lowering the return of this type of insurance policy.
Yet another type of insurance is whole life insurance, which provides coverage throughout the entire life of the insured. In this type of insurance, premiums are paid throughout the insured's life or for a portion thereof (e.g., for 10 years or 20 years). Further, the cash value portion of a whole life insurance policy belongs to the insured and may be withdrawn as a loan, however, any loans and interest charges accrued on the loans not paid back to the insurer reduce the death benefit payable to the insured. Alternatively, a whole life insurance policy may be surrendered for a predetermined percentage of its face value. Premiums paid into a whole life insurance policy are allocated between the insurance portion of the policy and the investment or cash portion of the policy. The investment portion of the policy usually consists of stocks, bonds and/or mutual funds.
Universal Life insurance is a variation of whole life insurance. Universal life insurance separates the term life portion of the policy from the investment, or cash portion, of the policy. In addition, the investment portion of the policy is invested in money market funds as opposed to stocks, bonds and mutual funds. The cash value portion of the policy is held in an accumulation account that investment interest is credited to and death benefits are paid from. Consequently, the insured can vary the amount of the annual death benefit because it is contingent upon the underlying variable investments.
There are two general types of universal life insurance. The first type provides a set death benefit for the insured regardless of premiums paid which keeps the policy in force. The second type sets the death benefit for the insured equal to a set amount plus the current cash value of the policy at the time of the insured's death.
Variable life insurance is also a form of whole life insurance. As with other insurance policies, part of the premium payment goes toward the term life portion of the policy, part to administrative expenses and part to the investment or cash value portion of the policy. The principal difference between variable life insurance and other types of insurance is that the insured is able to actively choose how to invest the funds in the investment portion of the policy. For example, the insured may select from an array of investments such as stocks, bonds and mutual funds as long as they are within the insurance companies portfolio. In variable life insurance, death benefits may fluctuate up or down depending upon investment performance.
In universal life insurance and variable life insurance policies, premiums are flexible and the internal rate of return may be higher because it moves with the financial markets. In addition, mortality costs and administrative charges are known.
However, both universal life and variable life insurances have similar disadvantages, which stem primarily from their flexibility. Cash values are not guaranteed and benefit payments can vary wildly because these policies lack the fundamental guarantee that the policy will be in force unless sufficient premiums have been paid. In other words, these types of insurance policies lapse unless the purchaser has paid a sufficient amount of premium payments to cover both the variable and fixed expenses of the product.
Because there are no life insurance products which have a high internal rate of return and a guarantee that the life insurance policy will not lapse, there is a clear need in the art for a life insurance product which incorporates both of these features.